A joint venture allows companies to collaborate quickly and without undertaking a full-scale merger. Joint ventures have emerged as the preferred vehicle for entering foreign markets and are being developed at a fast pace.

The CPA’s Role

Measurement and reporting. Myriad accounting and reporting standards for joint venture interests exist internationally. Areas of disagreement range from basic questions, such as what constitutes a joint venture, to complex recognition, measurement, and disclosure rules. For example, in the United States, APB Opinion No. 18 prescribes the equity method of accounting for corporate joint ventures but does not address the proper accounting treatment of partnerships or unincorporated joint ventures. Canada defines joint ventures more broadly and requires proportionate consolidation. The IASC defines a joint venture in a manner similar to Canada but permits either proportionate consolidation or the equity method. A CPA knowledgeable in these areas can interpret the various international standards, structure the collaborative arrangement according to management’s intentions, and then prepare appropriate financial statements and disclosures (See Exhibit 2).

To facilitate harmonization of the various international standards, the G4+1 group of standard setters has issued Reporting Interests in Joint Ventures and Similar Arrangements, a special report containing proposals for the accounting and disclosure of joint venture arrangements. Although the G4+1 recommendations do not constitute GAAP, they indicate the future direction of the various standards-setting bodies.

The concept of joint control is central to the G4+1 report. Joint control is defined as a situation in which “no one party alone has the power to control its strategic operating, investing, and financing decisions, but two or more parties together can do so, and each of the parties sharing control (joint venturers) must consent.” The G4+1 thinks that this definition gives the joint venture economic characteristics that merit distinctive measurement and reporting of its activities. The G4+1 further defines a joint venture as “an enterprise that is jointly controlled by the reporting enterprise and one or more other parties.” These two statements, taken together, exclude some forms of collaboration, such as cost-sharing arrangements.

In addition, the G4+1 proposes that a joint venture’s activities be measured using the equity method with disclosures that describe the complex nature of joint venture relationships. Such disclosures include the following:

Valuation services. Because setting up and capitalizing a joint venture from scratch can take years, a more attractive tactic is to purchase a portion of an existing business. This approach allows the joint venture to begin energized and realize profits at a relatively accelerated pace. However, this approach exposes the acquiring venturers to an element of business risk. If the venturers overpay, they may lose the economic advantages of a running start. A CPA’s expertise in business valuation can play a role in the formative stage of this type of joint venture. (A recent Wall Street Journal article included two of the Big Five in a top 10 list of advisors to mergers and acquisitions.)

Two popular valuation methods are rules of thumb and discounted cash flow analysis (DCF). The rules of thumb for valuing businesses in many industries provide a benchmark valuation. For example, analysts often refer to companies in an industry selling for a certain percentage of earnings, revenues, cash flow, or other financial characteristics. An advisor’s expertise in particular industries can help establish an initial estimate.

DCF models focus on a company’s prospective financial performance. The value of a company today is viewed as the projected future cash flows discounted to the present by an appropriate interest rate.

Of the innumerable valuation methods, each has advantages and is best applied in certain circumstances. Less important than the method is the expertise of the individual performing the valuation.

Due diligence review. The two main types of due diligence efforts undertaken are somewhat intertwined: legal due diligence and financial/operational due diligence.

The CPA is often the provider of choice for financial/operational due diligence procedures, which are often referred to as a business review. The purpose of such a review is to address a variety of areas, including but not limited to the following: